The full document, in zipped PDF file - 370KB
Inflation Report 2001, January-June
Governor's letter
Governor's letter
Jerusalem, July 30, 2001
The Inflation Report for the first half of 2001 is submitted to the government,
the Knesset, and the public as part of the process of monitoring the course
of inflation and adhering to the inflation targets set by the government, and
is intended to increase the transparency of monetary policy. Transparency
in the management of macroeconomic (fiscal and monetary) policy is
necessary in order to provide the certainty needed by foreign investors as
well as by Israelis who participate in the domestic and international financial
markets.
In August 2000 the government decided on a path of inflation targets for the next
defined as price -few years, aimed at attaining annual inflation rates of 1-3 percent
from 2003 onwards. After that point the role of monetary policy will be to -stability
maintain price stability, so defined. This will complete the process of disinflation,
and Israel will join western countries, which enjoy price stability maintained by
monetary policy.
In the first half of 2001 the Consumer Price Index rose by 1.1 percent, and current
assessments are that it will rise further, to 2-2.5 percent, during 2001 as a whole,
near the lower limit of this year’s target (2.5-3.5 percent) and within the range
defined as price stability. In order to attain the inflation target while maintaining
financial stability, especially in view of increased uncertainty in the economic
environment as a result of domestic and external shocks, the Bank of Israel has
by a cumulative 1.4 -gradually and consistently reduced its key interest rate
percentage points in the first half of 2001, and by another 0.5 percentage points
since then.
Despite the persistence, and even exacerbation, of the shocks to the economy
since the end of 2000-the security incidents, economic slowdown in the US, and
stability has been maintained in the financial -sharp drop in technology share prices
and foreign-exchange markets, largely due to the macroeconomic policy aimed at
extending it. In order to maintain this stability it is necessary to strive for continued
price stability as well as the reduction of the budget deficit and the public debt, in
accordance with the targets determined in the Budget Deficit Reduction Law,
5752-1992.
The apparent deviation of the deficit from the ceiling set for 2001 is also
expressed in a significant rise in the share of government expenditure in GDP and in
the public debt, contrary to the declared government policy of reducing these shares;
this constitutes a problematic point of departure for the 2002 budget. The challenge
will be to ensure that the departure from the path in 2001 is temporary, and that the
government returns to the path it set for itself in August 2001 of converging by
2003 to the Maastricht standards.
The composition of the government’s expenditure, reflecting its priorities, is
pivotal for attaining policy objectives, including returning to a path of sustainable
growth and reducing poverty. Significantly increasing infrastructure investment,
making education expenditure more efficient, and reforming transfer payments so as
to encourage labor-force participation, alongside a policy that focuses on alleviating
poverty, will help to attain those objectives. Structural change in the tax system
accompanied by an easing of the tax burden, once macroeconomic conditions allow
this, will increase economic efficiency and enable Israeli producers to compete in
the global economy.
Note, too, that it is important to continue progressing towards bringing
decision-making processes into line with the newly-established situation of price
stability: public-sector wage agreements must refrain from awarding automatic
wage increases that are the heritage of previous periods of rapid inflation, the
unindexed public debt must be extended for a term of fifteen years (in this context,
the issue of 10-year Shahar bonds is a step in the right direction, helping to create
an unindexed mortgage market), and the system of taxation and accounting
standards must be placed on a nominal basis, as is the case in western countries.
Furthermore, it is necessary to proceed with reforms that make the economy more
efficient and robust, stimulating employment and sustainable growth. These include
pension reform, serving to channel investment by pension funds to the capital
market and away from earmarked bonds, and to substitute pay-as-you-go pension
schemes for funded ones within the framework of a competitive market. Additional
features include abolishing the ceiling on Treasury bill issues in order to create the
infrastructure necessary for a nonbank money market, separating the provident and
mutual funds from the banks in order to establish a more competitive system of
financial intermediation, and amending the Mininumum Wage Law, including the
way it is updated, as well as introducing further reforms aimed at increasing
competition and making the allocation of resources more efficient.
The fact that the exchange rate has come closer to the lower limit of the band,
despite the depreciation of the NIS against the dollar, due inter alia to the
weakening of the euro, brings to the fore with renewed urgency the inconsistency of
adhering to an exchange-rate band in a regime of inflation targets, especially at a
time of convergence towards price stability and long-term capital inflow that is not
sensitive to short-term interest-rate differentials. The exchange-rate band has
outlived its usefulness, and it is time to remove it.
This Inflation Report was prepared at the Bank of Israel within the
headed by the -framework of the Senior Monetary Forum. The Forum
is the inter-departmental team (whose members include the -Governor
heads of the Monetary, Research, Foreign Currency, and Foreign
Exchange Control Departments) within which monetary policy decisions are
taken.
David Klein
Governor
Summary
* In the first half of 2001 (the period reviewed)1 the Consumer Price Index (CPI) rose
by 1.1 percent. Current assessments of the annual rate of inflation are in the 2-2.5
percent range-near the lower limit of the 2.5-3.5 percent target for the year, and in
line with the long-term target of price stability (1-3 percent) set by the government
for 2003 and subsequently.
* During the period reviewed the economic slowdown, which had served to moderate
price increases, persisted. The slowdown derived primarily from difficulties due to
the worsening security situation, the fall in prices of assets in international financial
markets, and the slowdown in western economies, chief among them the US; all
these factors could have undermined Israel's financial stability. However, Israel's
financial markets, including the foreign-exchange market, remained stable, largely
due to the macroeconomic policy geared towards attaining this goal.
* The NIS depreciated by 3 percent against the dollar in the period reviewed,
compared with appreciation during 2000. The exchange rate of the NIS against the
currency basket remained stable, steadying at 1-2 percent above the lower limit of
the exchange-rate band.
* During the period reviewed the Bank of Israel reduced its key interest rate by a total
of 1.4 percentage points. The interest rate reached 6.8 percent, so that since the
beginning of 1999 there has been a cumulative reduction of 6.7 percentage points.
The reduction of the interest rate in the period reviewed derived from the
assessment that forecast inflation (at the interest rate prevailing at the time) would
be below the inflation target for 2001, converging with the long-term target of price
stability.
* The gradual nature of the interest-rate cuts in the period reviewed was influenced
by the need to maintain financial stability, particularly in view of the increasing
instability in the economic environment due to domestic and external shocks.
* Lack of clarity regarding the extent to which the budget deficit would deviate from
its ceiling this year, and especially as regards the return to the budget deficit path
set for the next few years in the framework of convergence with international
standards, could impair price stability in the future, requiring tighter monetary
policy in order to maintain it.
* The fact that the exchange rate came closer to the lower limit of the exchange rate
band, despite the depreciation of the NIS against the dollar due to the weakening of
the euro, underlines the problematic nature and inconsistency of maintaining an
exchange-rate band in a regime of inflation targets, especially at a time of
convergence to price stability, and long-term capital inflow that is not influenced
by short-term interest-rate differentials.
* Adherence to a macroeconomic strategy that aspires to reduce the government
debt, the tax burden, and the share of public expenditure in GDP, while
increasing the share of growth-stimulating expenditure and maintaining price
stability, will help to create the necessary conditions for realizing Israel's growth
potential. The latter could be fulfilled once the domestic and external shocks
abate, with the easing of the security situation and resurgence of growth in
western economies, led by the US.
-------------------------------------------------------
1 The last eighteen months can be divided into two periods which do not necessarily follow the
customary calendar division into half years. The slowdown in the US economy, expressed in the
US stock market in October 2000 and subsequently and the fall in share prices in other
developed countries at that time, together with the outbreak of security unrest in the same
month, creates a natural division into the three quarters preceding October 2000, on the one
hand, and the three quarters following October 2000, on the other. The difference between the
two periods is notable as regards Israel’s growth rate, especially of exports, as well as in issues
by Israeli companies on the Nasdaq and other stock markets, and the resulting capital inflow.
Nevertheless, we have defined the period reviewed as the first half of 2001, and only in certain
respects does the analysis cover the period indicated by the course of events.
The full document, in zipped PDF file - 370KB
the Knesset, and the public as part of the process of monitoring the course
of inflation and adhering to the inflation targets set by the government, and
is intended to increase the transparency of monetary policy. Transparency
in the management of macroeconomic (fiscal and monetary) policy is
necessary in order to provide the certainty needed by foreign investors as
well as by Israelis who participate in the domestic and international financial
markets.
In August 2000 the government decided on a path of inflation targets for the next
defined as price -few years, aimed at attaining annual inflation rates of 1-3 percent
from 2003 onwards. After that point the role of monetary policy will be to -stability
maintain price stability, so defined. This will complete the process of disinflation,
and Israel will join western countries, which enjoy price stability maintained by
monetary policy.
In the first half of 2001 the Consumer Price Index rose by 1.1 percent, and current
assessments are that it will rise further, to 2-2.5 percent, during 2001 as a whole,
near the lower limit of this year’s target (2.5-3.5 percent) and within the range
defined as price stability. In order to attain the inflation target while maintaining
financial stability, especially in view of increased uncertainty in the economic
environment as a result of domestic and external shocks, the Bank of Israel has
by a cumulative 1.4 -gradually and consistently reduced its key interest rate
percentage points in the first half of 2001, and by another 0.5 percentage points
since then.
Despite the persistence, and even exacerbation, of the shocks to the economy
since the end of 2000-the security incidents, economic slowdown in the US, and
stability has been maintained in the financial -sharp drop in technology share prices
and foreign-exchange markets, largely due to the macroeconomic policy aimed at
extending it. In order to maintain this stability it is necessary to strive for continued
price stability as well as the reduction of the budget deficit and the public debt, in
accordance with the targets determined in the Budget Deficit Reduction Law,
5752-1992.
The apparent deviation of the deficit from the ceiling set for 2001 is also
expressed in a significant rise in the share of government expenditure in GDP and in
the public debt, contrary to the declared government policy of reducing these shares;
this constitutes a problematic point of departure for the 2002 budget. The challenge
will be to ensure that the departure from the path in 2001 is temporary, and that the
government returns to the path it set for itself in August 2001 of converging by
2003 to the Maastricht standards.
The composition of the government’s expenditure, reflecting its priorities, is
pivotal for attaining policy objectives, including returning to a path of sustainable
growth and reducing poverty. Significantly increasing infrastructure investment,
making education expenditure more efficient, and reforming transfer payments so as
to encourage labor-force participation, alongside a policy that focuses on alleviating
poverty, will help to attain those objectives. Structural change in the tax system
accompanied by an easing of the tax burden, once macroeconomic conditions allow
this, will increase economic efficiency and enable Israeli producers to compete in
the global economy.
Note, too, that it is important to continue progressing towards bringing
decision-making processes into line with the newly-established situation of price
stability: public-sector wage agreements must refrain from awarding automatic
wage increases that are the heritage of previous periods of rapid inflation, the
unindexed public debt must be extended for a term of fifteen years (in this context,
the issue of 10-year Shahar bonds is a step in the right direction, helping to create
an unindexed mortgage market), and the system of taxation and accounting
standards must be placed on a nominal basis, as is the case in western countries.
Furthermore, it is necessary to proceed with reforms that make the economy more
efficient and robust, stimulating employment and sustainable growth. These include
pension reform, serving to channel investment by pension funds to the capital
market and away from earmarked bonds, and to substitute pay-as-you-go pension
schemes for funded ones within the framework of a competitive market. Additional
features include abolishing the ceiling on Treasury bill issues in order to create the
infrastructure necessary for a nonbank money market, separating the provident and
mutual funds from the banks in order to establish a more competitive system of
financial intermediation, and amending the Mininumum Wage Law, including the
way it is updated, as well as introducing further reforms aimed at increasing
competition and making the allocation of resources more efficient.
The fact that the exchange rate has come closer to the lower limit of the band,
despite the depreciation of the NIS against the dollar, due inter alia to the
weakening of the euro, brings to the fore with renewed urgency the inconsistency of
adhering to an exchange-rate band in a regime of inflation targets, especially at a
time of convergence towards price stability and long-term capital inflow that is not
sensitive to short-term interest-rate differentials. The exchange-rate band has
outlived its usefulness, and it is time to remove it.
This Inflation Report was prepared at the Bank of Israel within the
headed by the -framework of the Senior Monetary Forum. The Forum
is the inter-departmental team (whose members include the -Governor
heads of the Monetary, Research, Foreign Currency, and Foreign
Exchange Control Departments) within which monetary policy decisions are
taken.
David Klein
Governor
Summary
* In the first half of 2001 (the period reviewed)1 the Consumer Price Index (CPI) rose
by 1.1 percent. Current assessments of the annual rate of inflation are in the 2-2.5
percent range-near the lower limit of the 2.5-3.5 percent target for the year, and in
line with the long-term target of price stability (1-3 percent) set by the government
for 2003 and subsequently.
* During the period reviewed the economic slowdown, which had served to moderate
price increases, persisted. The slowdown derived primarily from difficulties due to
the worsening security situation, the fall in prices of assets in international financial
markets, and the slowdown in western economies, chief among them the US; all
these factors could have undermined Israel's financial stability. However, Israel's
financial markets, including the foreign-exchange market, remained stable, largely
due to the macroeconomic policy geared towards attaining this goal.
* The NIS depreciated by 3 percent against the dollar in the period reviewed,
compared with appreciation during 2000. The exchange rate of the NIS against the
currency basket remained stable, steadying at 1-2 percent above the lower limit of
the exchange-rate band.
* During the period reviewed the Bank of Israel reduced its key interest rate by a total
of 1.4 percentage points. The interest rate reached 6.8 percent, so that since the
beginning of 1999 there has been a cumulative reduction of 6.7 percentage points.
The reduction of the interest rate in the period reviewed derived from the
assessment that forecast inflation (at the interest rate prevailing at the time) would
be below the inflation target for 2001, converging with the long-term target of price
stability.
* The gradual nature of the interest-rate cuts in the period reviewed was influenced
by the need to maintain financial stability, particularly in view of the increasing
instability in the economic environment due to domestic and external shocks.
* Lack of clarity regarding the extent to which the budget deficit would deviate from
its ceiling this year, and especially as regards the return to the budget deficit path
set for the next few years in the framework of convergence with international
standards, could impair price stability in the future, requiring tighter monetary
policy in order to maintain it.
* The fact that the exchange rate came closer to the lower limit of the exchange rate
band, despite the depreciation of the NIS against the dollar due to the weakening of
the euro, underlines the problematic nature and inconsistency of maintaining an
exchange-rate band in a regime of inflation targets, especially at a time of
convergence to price stability, and long-term capital inflow that is not influenced
by short-term interest-rate differentials.
* Adherence to a macroeconomic strategy that aspires to reduce the government
debt, the tax burden, and the share of public expenditure in GDP, while
increasing the share of growth-stimulating expenditure and maintaining price
stability, will help to create the necessary conditions for realizing Israel's growth
potential. The latter could be fulfilled once the domestic and external shocks
abate, with the easing of the security situation and resurgence of growth in
western economies, led by the US.
-------------------------------------------------------
1 The last eighteen months can be divided into two periods which do not necessarily follow the
customary calendar division into half years. The slowdown in the US economy, expressed in the
US stock market in October 2000 and subsequently and the fall in share prices in other
developed countries at that time, together with the outbreak of security unrest in the same
month, creates a natural division into the three quarters preceding October 2000, on the one
hand, and the three quarters following October 2000, on the other. The difference between the
two periods is notable as regards Israel’s growth rate, especially of exports, as well as in issues
by Israeli companies on the Nasdaq and other stock markets, and the resulting capital inflow.
Nevertheless, we have defined the period reviewed as the first half of 2001, and only in certain
respects does the analysis cover the period indicated by the course of events.
The full document, in zipped PDF file - 370KB
